Walsh taps into source to ensure Rio rolls on

Pretty much from the moment
Rio Tinto
so unexpectedly became
Sam Walsh
’s domain, it was clear Mr Iron Ore wanted to look back to find a way forward.

So it was that Walsh decided to call
Chris Lynch
, the Broken Hill boy who had once directed
BHP
Billiton’s finances and had most recently steered toll road operator
Transurban
.

Lynch famously has a happy habit of making the tough sound all too easy. And over a call that ultimately led to his joining Rio as CFO, the pair breezily charted a recovery plan built around this theme of recovered history.

The conversation focused almost exclusively on the obvious. Rio needed to rebuild market confidence. That would come only from getting the balance sheet in order by continuing to account for errors past, by embracing new capital spending disciplines, by building free cash flows and by paying down debt.

The pair agreed it was painfully obvious there was no clear plan to tackle the debt issue. As a result the business was excessively vulnerable to the uncertain ebb and flow of commodities prices and to the pace of asset disposals.

So it was that costs, productivity and a new era of old disciplines became the focus of Walsh’s three-year campaign. And the endgame for Walsh’s compact with his investors is that by 2015, Rio will be in a position to offer its owners a bigger share of the post-boom bounty.

These are the themes of our times in the resources sector and we will hear them repeated time and again through this profit season and beyond.

A massive investment cycle is coming to a close and the miners have turned their focus on refining their new machinery to manufacture the best possible returns and on meeting the unsated expectations of owners who feel they have not enjoyed their share of the resources boom.

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Rio’s impressive FY13 profit numbers announce plainly that Walsh is comfortably ahead of his schedule. Sustainable pre-tax cost savings of $US2.3 billion ($2.5 billion) leave the company 15 per cent ahead of the first year target.

Cash flows of $US22 billion were much stronger than forecast and net debt currently sits at something near $US17 billion, which leaves the company within reach of the mid-teens target range that Lynch reckons would bring comfort enough to contemplate shareholder enriching capital management.

Given the $US1 billion from the sale of Clermont will lob by, maybe, April, it seems pretty certain that Rio will be in its preferred debt range by end of the June half.

But Walsh is insistent that Rio will not get ahead of itself here. He urged against any expectation that the payday for shareholders might be bought forward.

Through Thursday night’s investor briefings, Walsh and Lynch made it clear that the 15 per cent dividend hike is it for the moment, that shareholders could bank on an interim set by the current pay-out guidelines, which would mean something like US96¢, and that FY14 would remain a year of living conservatively with free cash flow being thrown at the balance sheet.

It is worth reflecting on the financial freedom that Rio is building into its balance sheet.

Walsh is committed to raising the repeatable cost savings’ bar to $US3 billion this year.

He is also committed to reducing Rio’s capital spend from $US11 billion to $US8 billion through FY14 and then lowering that again in FY15. And there is confidence that production increases in iron ore and copper will, at worst, mitigate any pricing softness through to and beyond 2015.

Which would seem to leave Rio looking at a power of options in FY15.

Like Rio Tinto,
Newcrest
is a miner embracing cost control as its pathway to confidence recovery. And, like Rio, it has delivered early results comfortably ahead of market expectations.

No question, the hard yards dashed by boss
Greg Robinson
through a year of crisis management have generated obvious and encouraging traction.

But, before anyone gets carried away with that idea of out-performance, let it be said that the expectations woven by Robinson were disappointingly low for a company of Newcrest’s pedigree.

And that is, ultimately, why the goldminer lost and gained a chairman at December’s end and why Robinson will move on at some point through the closing months of this year.

It is worth noting that an understandably sensitive Newcrest was forced to market disclosure just 24 hours before the release of its profit numbers by speculation that the company would pursue new capital to buttress a balance sheet that appeared to be carrying peak-load debt.

But that is not the plan, even though Friday morning’s numbers show that gearing has topped 30 per cent, which is twice the preferred level of 15 per cent.

And despite the fact that the company is still running at negative cash flow, leaking $229 million through the first half. Mind you, that is a huge improvement on the $900 million-plus outflow of the immediately previous half. The company says the better than expected cost, revenue and underlying profit performance of the first half sustains its comfort with a debt position that might well get slightly worse before it gets better.

Newcrest called out, for example, that it had undrawn established facilities of $1 billion that had recently been further bolstered by an additional $US200 million three-year facility.

Newcrest reaffirmed that it would run free cash flow positive by year’s end at an average realised gold price of $1450 an ounce.

There are a number of core levers to keep an eye on in assessing Newcrest’s progress to cash flow neutrality and beyond: production volumes, all-up production cost, exchange rates and gold price.

Two of those, volumes and cost, are mostly within management’s reach to control. And for the past three quarters they have largely over-reached targets.

With volumes running at 1.2m ozs through the half at an average all up cost of just more than $1000oz, Newcrest iis plainly getting its operational house in sector-leading order. And ,management insists there is headroom yet for improvement.

Less certain, of course, is the intricate interplay of US dollar exchange rates and the gold price that left Newcrest with an average realised gold price of $1405 an ounce through the December half.

The word is that
Rio Tinto
and
BHP
Billiton were forced to pay the price of ensuring that workers at projects all over the Pilbara were not left stranded by Forge Group’s financial collapse. Forge slipped into administration on Monday, triggering the loss of all but two of its contracts and by Tuesday it was in the hands of the receivers. KordaMentha arrived to find there was literally no cash left. So, not only were an estimated 700 or so Pilbara workers unemployed, they also had make their own way back to home. With that news, Rio and BHP stepped in, organising charter flights to deliver the workers home.